Finding a common ground

Can Islamic fintechs help the financial sector hit the UN’s Sustainable Development Goals? There is growing optimism but the industry is divided, Justin Cash reports

As global finance continues its sluggish progress towards the UN’s Sustainable Development Goals (SDGs), there is growing optimism that two major trends could help speed the way. The first is the growth of environmental, social and governance (ESG) investing, which is being given a boost by regulation such as the EU’s Corporate Sustainability Reporting Directive. The second is the boom in Islamic finance.

“Religious investors have long sought to align their financial returns with their ethical beliefs and broader values,” says Sally Kramers, Head of Industry Development at the UK Sustainable Investment and Finance Association. “A core tenet of Islamic scripture - and therefore of Islamic finance – is to not cause harm. In this sense, there is a clear connection between Islamic finance and sustainability… The sector has been experiencing rapid growth and there is a tremendous opportunity for it to drive meaningful change.”

Islamic finance is based on the belief that money should not have any value in and of itself. You should not be able to make money from money

Islamic finance and ESG investing can work together, powered by developments in financial technology. However, industry experts caution that the pair may not always work in harmony.

Globally, the Islamic finance market is projected to reach $4.94tn by 2025, according to Refinitiv, a global provider of financial market data. But such sums would still be dwarfed by conventional finance. The US bond market, for example, saw issuance of $1.7tn in the year to October 2024 and had around $11tn outstanding. But the trend for Islamic finance is upward. According to London Stock Exchange Group (LSEG) data, 2023 was the highest year on record in terms of the issuance of sukuks – Sharia-compliant bonds – at $214.9bn.

While many think such opportunities are unique to Muslim countries, particularly in the Middle East and Malaysia, Muslim populations are growing in the western world. The UK’s Muslim population could rise from 6.3% in 2016 to 17.2% by 2050, according to Statista research. And the Muslim population tends to be younger and better educated than average, according to a Muslim Council of Britain analysis of census data.

That opens up opportunities for fintechs. The likes of Islamicly, a Sharia-compliant stock trading app; Kestri, a ‘Muslim money app’; Qardus, an ‘ethical, Sharia-compliant finance platform’; and Simply Ethical, a ‘provider of Sharia-compliant and socially responsible investment solutions’, are vying to serve the growing demographic.

Being ethical and socially responsible is considered to be what sets Islamic finance apart. The Bank of England notes: “Islamic finance is based on the belief that money should not have any value in and of itself. It is just a way to exchange products and services that do have a value. In other words, you should not be able to simply make money from money. Another central principle is that money should not cause harm. Islamic finance also encourages partnership and so, wherever possible, profit and risks should be shared.”

With those principles in mind, The Global Islamic Finance SDG Taskforce, run by the UK Islamic Finance Council and the Treasury, held meetings twice a year between 2020 and 2022 in different jurisdictions to tackle the “limited engagement by the global Islamic finance sector” in the SDGs. While that group has now disbanded, fintechs are playing a key role in renewed efforts to marry environmentalism and Islamic finance. Gatehouse Bank, a challenger UK bank offering Sharia-compliant savings, was a founding signatory to the UN Principles for Responsible Banking when it launched in September 2019, for example.

ESG and green sukuk issuance tripled from 2019 to 2023 fuelled by transition-financing needs, according to the LSEG. According to FitchRatings, issuance of ESG sukuks will cross $50bn outstanding globally within the next two years.

“When people think of Islamic finance they often think about prohibitions on charging interest or ‘not doing harm’ by investing in areas such as alcohol, tobacco and gambling,” says Omar Salem, a partner at law firm Fox Williams, who has helped launch Sharia-compliant financial products. “However, Islamic finance is much broader than that and overlaps with what people generally think of ESG in many ways. For example, ‘not doing harm’ from an Islamic finance perspective can also extend to limiting carbon emissions and having a positive impact on the wellbeing of stakeholders such as customers and employees.”

Another principle of Islamic finance is that investment should be productive, and that it is wrong to ‘make money from money’. This supports a responsible approach to investment, in much the same way that traditional financial regulation aims to. Like the Christian prohibition on usury, Islamic finance contains a principle of avoiding financial exploitation.

The question is whether SDG, ESG-friendly Islamic fintechs go mainstream. That would mean breaking out of a niche

“There is an increasing recognition of the commonalities between ESG and Islamic finance, with fintechs that, for example, do not charge interest but also work to limit their carbon emissions,” says Salem.

However, the overlap between Sharia law and ESG is an imperfect one. “Islamic investment has a very specific and scriptural aim, often including negative screens that wouldn’t necessarily be in line with the SDGs,” Kramers says. “A sustainable fund might have no qualms investing in an alcohol distillery, provided it met the fund’s environmental and social criteria, while that would likely fall under the exclusion criteria for an Islamic fund.”

Another policy expert notes that Islamic finance is based mainly on exclusions, with tried and tested principles and an established governance structure, while ESG is generally much broader and is still evolving. Fintechs are also much more open to innovation. “[ESG] is not just focused on exclusions but on proactive stewardship and, in some cases, not just doing no harm but actively seeking ‘good’ outcomes,” the expert says.

Nor is fintech always environmentally friendly. Bitcoin, for instance, uses more electricity each year than entire countries such as Ukraine and Pakistan, the Cambridge Centre for Alternative Finance has estimated. A Zhejiang University and Nankai University study that looked at emissions from 79 major AI systems between 2020 and 2024 found that the world’s top AI tools collectively emit more than 102m tons of CO₂ per year,

Samina Akram, Managing Partner at Samak Ethical Finance and former head of Merrill Lynch International Bank’s Islamic finance wealth management business, acknowledges that Islamic law and sustainability are “not perfectly aligned”. But as Islamic finance matures, some issues will be ironed out, she believes.

“The Islamic finance sector as we recognise it is only 40 to 50 years old, and its focus has been largely on asset-backed financing, ensuring that transactions are backed by tangible assets,” Akram adds. “The banks haven’t in many ways stressed the SDGs. It has taken the ESG space to re-evaluate our intentions: it will take time for ESG principles to completely align. However, we are beginning to see activity unfolding, especially in these past few years.”

Although change will take time, technology is one potential tailwind for Islamic finance. As part of its recovery plan in the wake of the Covid-19 pandemic, Malaysia, a Muslim-majority country, launched its first digital sukuk in 2020, followed in 2023 by the launch of the world’s first tokenised sukuk linked to a sovereign instrument. The LSEG notes that AI could potentially improve the efficiency of sukuks – reducing costs and increasing their accessibility to a wider range of investors.

“This is about what tech is required to modernise Islamic finance,” says Mike Coombes, Chief Corporate Affairs Officer at capital markets technology firm PrimaryBid. “There’s all the basic stuff, of course, like better Sharia compliance tracking... But what about something more exciting about blockchain or smart contracts? I’d think that smart contracts for Sharia compliance was quite a nice idea, like a digital sukuk and asset tokenisation under Islamic finance rules.”

November 2024 was anti-Islamophobia month in the UK. Fintech, visible to and accessible by wide user demographics could also help build bridges between traditional and Sharia finance.

“I guess the question is then whether SDG, ESG-friendly Islamic fintechs go mainstream,” Coombes says. “Doing that would mean breaking out of a niche (at least in the UK), appealing to non-Muslim consumers and demonstrating where ESG and Islamic principles overlap.”

Justin Cash is Online Editor at Dow Jones’s Financial News title. He was previously Editor of Money Marketing magazine and has also worked for titles including Legal Week and Citywire